Federal Policy Makers Set Their Sights on State and Local Governments: We Continue to See Federal Legislative and Regulatory Efforts That Would Increase Cost to and Oversight of State and Local Governments

Federal Policy Makers Set Their Sights on State and Local Governments: We Continue to See Federal Legislative and Regulatory Efforts That Would Increase Cost to and Oversight of State and Local Governments

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The first six months of 2014 continued an alarming trend of federal legislative and regulatory efforts that would increase costs to and oversight of state and local governments. Congress and the White House remain steadfast in their legislative pursuit of budget deficit reduction by any means possible. As their focus in this area has sharpened, the emphasis has migrated beyond continued cuts to federal programs that benefit state and local governments to proposals for reforming the federal tax code--which contain costly provisions for governments. Apart from these legislative overtures, within the last few months, the Securities and Exchange Commission and U.S. Department of Treasury have announced new initiatives that seek to broaden federal regulatory authority over state and local government bond issuers.

ALARMING LEGISLATION

On February 26, 2014, House Ways and Means Committee Chairman Dave Camp (R-Michigan-4) released a draft comprehensive federal tax reform proposal that would repeal more than 200 sections of the tax code and reduce the existing seven-bracket tax code system to three brackets. As part of this plan, Camp also proposes to eliminate the state and local tax deduction and advanced refundings, as well as imposing a 10 percent deduction cap on tax-exempt bond interest for individuals earning more than $400,000 and couples earning more than $450,000. If enacted, this proposal would make tax-exempt bonds taxable for these income earners and repeal the tax-exempt status of municipal bonds that has existed for more than 100 years. The GFOA has consistently objected to previous proposals that would change the tax exemption as they would increase borrowing costs for state and local governments in financing critical infrastructure projects. But such proposals --along with the loss of the state and local tax deduction, at a time when federal discretionary spending to state and local governments is at its lowest point in four decades--could further dampen the state and local government sector's economic recovery and create a drag on the national economy.

Since 2011, the White House has included language in its annual budget proposals that would cap all investor deductions and exclusions at 28 percent, including the tax exemption on municipal bond interest. According to industry reports, the proposal to cap the tax benefit of the tax exemption at 28 percent would increase borrowing costs to government debt issuers by 70 basis points. Further, according to the 2013 report Protecting Bonds to Save Infrastructure and Jobs, (1) state and local government borrowing costs would have been $173 billion greater than they were over the past 10 years if the 28 percent cap had been in place. In 2014, the White House again included its 28 percent cap proposal in its budget for the coming fiscal year.

Meanwhile, the Senate Finance Committee, under the new leadership of Chairman Ron Wyden (D-Oregon), is also considering sweeping changes to the federal tax code that could include modifications to the tax exemption. While the committee is currently preoccupied with enacting a package of short-term tax extenders and organizing a temporary patch for the Medicare sustainable growth rate, its new chairman is expected to turn to comprehensive tax reform in the fall. The GFOA has concerns about the direction Wyden will take on the tax exemption, as he coauthored a bill in 2011 that would have eliminated the interest deduction for new state and local debt in favor of providing a tax credit to issuers equivalent to 25 percent of the interest payments on the debt. The bill would have also eliminated advance refundings for governments and nonprofit organizations.

Wyden defends this proposal by saying the tax exemption is chiefly a benefit to wealthy investors, and replacing the exemption with a tax credit bond subsidy would be more inclusive and would distribute the tax benefit to a larger number of income groups. …